Insurance – Page 52 – The Aleph Blog

Changes in My Insurance Longs

Posted on 3 July 20073 July 2007 by David Merkel

I have updated my insurance longs over at Stockpickr.com. (At present, I have no shorts, but if I did, I would not reveal them. Check my disclosure policy for details.) Here are the major changes:

I have sold Reinsurance Group of America, Allstate, Scottish Re (there was only a stub left), Endurance, Allied World, and Employers Holdings. I have bought Safety, Aspen, Argonaut, and PXRE. These changes have take place over the past few months. I have not mentioned them until now, because my employer was still building positions in the names; we are done now.
Why the changes? Here goes: with the exception of Scottish Re, I still like all of the companies and their management teams. By name:

Allied World and Endurance — nice runs. Not sure I want to hold them through storm season.
Aspen is a cheap substitute for AWH and ENH, maintaining some of my property exposure cheaper.
Argonaut and PXRE — merging. Argonaut got PXRE cheaply, and the deal makes good long term sense. Argonaut re-domiciles in Bermuda, and slow lowers its tax rate. It also further diversifies by writing property reinsurance, but not too much.
Allstate — I still own this in the broad market portfolio, but that has different objectives than the hedge fund that I work for. It has a longer time horizon. In the short run, Allstate will be pressured by increasing competition in the personal lines space. On the other hand, what a cheap valuation. I like it!
Scottish Re — can’t write new business. Very opaque earnings model. It is a pig in a poke, and I don’t think one can trust the book value.
Employers Holdings — I have to beg a mea culpa here, and say that my initial article on RealMoney was wrong. My goof? The prospectus was complex, badly worded, and I mis-estimated the true share count. After figuring out the true share count, I realized that the stock was fairly valued, not cheap. Apologies to all who went in with me on this; at least if I have to make an error, better to make it when no big losses are made.
Reinsurance Group of America — a real class act, but past my valuation parameters for now.
Safety Insurance — Very well run pure play personal lines insurer in Massachusetts, and cheap! Insulated from the general competition in personal lines in the USA.

Anyway, that’s what I am up to in insurance now, and how my portfolio differs from where I was in the first quarter.

Full disclosure: long AHL, AGII, ALL, PXT, and SAFT

How Do You Value an Insurance Business?

Posted on 6 June 20076 June 2007 by David Merkel

As Paul mentioned in the comments on the last post, I answered a question at Stockpickr.com today. James Altucher, the bright guy who founded the site, asked me if I would answer the question, and so I did. Here is a reformatted version of my answer, complete with links that work:

Q: Any thoughts on how to value an insurance business? What are the best metrics to use? In particular I’m looking at small cap insurers (P&C) as potential acquisition targets. Does that change the methodology?

A: That’s not an easy question, partly because there are many different types of insurance companies, and each type (or subsector) gets valued differently due to the degree of growth and/or pricing power for the subsector as a whole.

Now, typically what I do as a first pass is graph Price/Book versus return on equity for the subsector as a whole, and fit a regression line through the points. Cheap companies trade below the line, or, are in the southeast corner of the graph.

But then I have to make subjective adjustments for reserve adequacy, excess/noncore assets, management quality, pricing power on the specific lines of business that write as compared to their peers, and any other factors that make the company different than its peers. When the industry is in a slump, I would have to analyze leverage and ability of the company to upstream cash from its operating subsidiaries up to the parent company.

Insurance is tough because we don’t know the cost of goods sold at the time of sale, which requires a host of arcane accounting rules. That’s what makes valuation so tough, because the actuarial assumptions are often not comparable even across two similar companies, and there is no simple way to adjust them to be comparable, unless one has nonpublic data.

My “simple” P/B-ROE method above works pretty well, but the ad hoc adjustments take a while to learn. One key point, focus on management quality. Do they deliver a lot of negative surprises? Avoid them, even if they are cheap. Do they deliver constant small earnings surprises? Avoid them too… insurance earnings should not be that predictable. If they become that predictable, someone is tinkering with the reserves.

Good insurance managements teams shoot straight, have occasional misses, and over time deliver high ROEs. Here are three links to help you. One is a summary article on how I view insurance companies. The second is my insurance portfolio at Stockpickr. The last is my major article list from RealMoney. Look at the section entitled, “Insurance & Financial Companies.”

Now, as for the small P&C company, it doesn’t change the answer much. The smaller the insurance firm, the more it is subject to the “Law of Small Numbers,” i.e., a tiny number of claims can make a big difference to the bottom line result. Analysis of management, and reserving (to the extent that you can get your arms around it) are crucial.

As for takeover targets, because insurers are regulated entities, they are difficult to LBO. Insurance brokers, nonstandard auto writers, and ancillary individual health coverage writers have been taken private, but not many other insurance entities. State insurance commissioners would block the takeover of a company if it felt that the lesser solvency of the holding company threatened the stability of the regulated operating companies. The regulators like strong parent companies; it lets them sleep at night.

One more note: insurance acquisitions get talked about more than done, because acquiring companies don’t always trust the reserves of target companies. Merger integration with insurance companies has a long history of integration failures, so many executives are wary of being too aggressive with purchases. That said, occasionally takeover waves hit the insurance industry, which often sets up the next round of underperformance, particularly of the acquirers.

Bottom Left Hand Drawer Issues

Posted on 29 May 20076 January 2011 by David Merkel

Back in the saddle.? I have a lot to write about, but not so much time.? The insights developed over vacation will be spread out over the next week or so.

Just a quick one to get started.? In general, I think insurance companies with more than $100 million in assets should have their own investment departments, and not outsource the management of assets.? (Note: to any insurance CEOs reading this — would you like a chief investment officer with experience in all major fixed income classes, equity, and derivatives, and a knowledge of the actuarial side of investing as well?? E-mail me, and we can talk.)

I only know one insurance asset outsourcing larger than this, but Safeco has outsourced their asset management to Blackrock.? I think that it is a mistake.? Why?

Insurance companies excel at creating tailored liabilities, taking individual risks away, and pooling them.? The same should be done with assets.? Anyone can hire Blackrock (a very good firm), but an intelligent management will take the time and effort to develop in-house expertise, which is usually cheaper than most third party solutions.? It gives up what should be a profit center for the enterprise as a whole.
Third-party arrangements miss what I call “The Bottom Left Hand Drawer” issues.? I worked in insurance for 17 years, and I grew to love the competent but uncelebrated people in the company that did excellent work, but management thought were expendable.? Third-party relationships lack the freedom for customization that in-house management allows for.? Often because accounting systems don’t get it quite right, human intervention is needed.? Someone makes an adjustment off of a schedule that they keep in their bottom left hand drawer once a year, and that keeps the system running right.? In a third party solution, those issues can get lost; I have personally seen it fail.
Penny wise, pound foolish.? The explicit expense savings are easy to see, but the implicit losses from not having someone managing the investments that is totally on your side is hard to measure.? Though I can’t prove it, the soft costs are large.

If I served an insurance company again as an asset manager, I would want to serve that company only, and not run a third-party asset management shop.? The work of an insurance company is important enough that it deserves the undivided attention of professionals on staff.

Insurance Earnings So Far 1Q07 — XII (Final)

Posted on 17 May 200718 May 2007 by David Merkel

Only three more companies to mention since my last post, here goes:

Primary Commercial

Employers Holdings beats estimates, but on falling premium volume. North Pointe misses earnings on falling premium volume, a higher loss ratio, and expansion expenses that can’t be deferred. Their acquisition looks interesting though; should be accretive to earnings.

Personal Lines

Affirmative Holdings misses estimates badly. More premiums, but higher loss and expense ratios.

Quarter End Summary

Here are the themes of the quarter. I would expect them to persist into the next quarter, which is what normally happens, but when themes don’t persist, the adjustment to prices can be severe.

Though the sell side has gotten into greater agreement with the idea that the top line doesn’t matter much (an idea that I support), the buy side did not agree this quarter. In general, companies that grew their premiums were rewarded, and vice-versa for those who shrank or stood still.
What worked: Primary Commercial, The Bermudans, Financial Guarantors and Life Companies. With Life companies, in general, the larger companies, and the ones with greater exposure to asset management did better. With Primary Commercial insurers and the Bermudans, in general the less conservative did better.
What sort of worked: Personal lines and Conglomerates.
Indeterminate: Title Insurers.
What didn’t work: Brokers, Mortgage Insurers and Specialty Credit players. Credit trends were poor in the first quarter, and brokers faced shrinking revenue from shrinking premium rates.

That was the quarter as I saw it. Did you find this series valuable? If so, e-mail me at the address listed at the Aleph Blog. I have a few ideas on how to make it better, but perhaps this is too superficial to be of use. If so, tell me, and I’ll focus on other things.

Full Disclosure: long NPTE

Back From Bermuda

Posted on 16 May 2007 by David Merkel

My blog isn’t meant to be mostly about insurance, but I’ve been writing about it a lot lately.? After this, I should have one more wrap-up post about first quarter earnings, and that should be it.

My Bermuda trip went well.? Here’s what I learned:

On net, pricing is actually improving at present.? Property rates have been improving, with 6/1 and 7/1 renewals at the same level as last year.? Casualty rates continue to deteriorate across almost all lines with aviation and D&O possibly having the most overcapacity.? Florida rates have been improving, because insurers are buying coverage above the Florida Hurricane Catastrophe Fund, and second event coverage as well.? Demand is high.? (And Florida is not charging anywhere near enough for reinsurance in their fund… a disaster waiting to happen.)
Everyone wants to expand their specialty businesses, whether through tuck-in acquisitions, or lift-outs of underwriting teams.? At the same time, more of the business is being written standard by admitted writers.
Because capacity with the highly rated carriers is adequate, the class of 2005 is having a hard time gaining enough business.? This is exacerbated by the insureds generally taking higher deductibles, and insurers retaining more and ceding less.? Also, sidecars are less needed in such an environment; many are maturing, and disappearing.
“Revenge of the Nerds” could have been the theme of the meetings.? Only?two of the 10 companies is growing their business.? Most are doing?buybacks, and rest, minus Axis, are considering it.? All of them are following roughly the same investment models (excluding Max Capital), and all of them are following roughly the same risk control strategy, though a few are limiting their writings at absolute limits, rather than probability based limits, which have been known to overexpose companies when rare bad events hit.
Conservatism is generally a good, but over-conservatism is a bad.? Platinum Underwriters is too conservative, and is losing vitality by not writing business unless they are almost certain they will make a 10% ROE.? They are shrinking now.
Finally, reserves are the biggest area of disagreement.? Everyone says their own reserves are conservative, but few are willing to prove it, like PartnerRe and ACE.? XL may be going that way as well, disclosing reserve triangles.? In general it seems that if there are problems, it should be located in the portfolios of the heavier Casualty writers, like ACGL.

I came away relatively happy with our positions.? I like Allied World, Endurance, and PartnerRe roughly equally well.? I was impressed with Flagstone, and think that it could be a good buy during a wind crisis.? Arch and Max Capital presented well; there are reserving questions with Arch though.? XL did well, but I still wonder if they have control over their lines the way PartnerRe does.? Platinum is too conservative, and Axis smacked of braggadocio, somewhat touchy and defensive.? Answers were among the least clear given.

Final note, on people: The Arch meeting was a hoot.? They spoke their minds and dished on everyone, though not by name (clever analysts know, though).? XL’s CEO expressed contempt for MR Greenberg (“glad he’s gone”), and AWH’s CEO talked about his friendship with Greenberg, and how it is bringing AWH business.? Going with Harry Fong was a plus — his 30 years of experience is unmatched, and he has a quirky way of teasing the answers out.

Full disclosure: long AWH ENH

Insurance Earnings So Far 1Q07 — XI

Posted on 10 May 2007 by David Merkel

We’re going to end this one at a dozen, cousin.? Leaving aside a few new and oddball names, by Tuesday of next week virtually everyone will have reported.? So, after I get back from Bermuda, I will finish this series up.

Bermuda?? Business only.? Going to hit about a dozen companies in two days with one of my favorite P&C analysts, Harry Fong of Calyon.? I hope there are a decent number of insurance only buy-side analysts along for the ride.? They make grilling the management teams so much fun.

As an aside, the last time I was in Bermuda was after Wilma.? I was traveling with Bill Wilt of Morgan Stanley (another good analyst).? Because of a glitch, only seven buy-side analysts analysts were on the trip, but four were “insurance only.”? Between us and Bill, we got a lot done.? The meetings were free-form, with a lot of good give and take.

But the night before the meetings started, I had just gotten to my hotel, and I was hungry.? The hotel bar was the only thing open, so I went down with my computer to get a burger or something.? While sitting there, waiting for my food to come, I work on a RealMoney article.? A fellow that I have never met walks up to me and says, “You’re David Merkel; what are you doing here?”? I am floored; I ask him how he knew me, and he said that I wrote for RealMoney.? Amazing what that little picture will do.

He explains to me that he is there for the Bermuda tour.? I tell him that I am glad he is there for the Morgan Stanley tour.? He looks at me puzzled and says he is there for the Lehman tour.? The Lehman tour is well planned… too well planned.? 24 analysts in all.? Whereas we got the give and take, they got the canned presentations.? Oh well.

Wait, this was supposed to be about earnings.? We have only two companies.? AIG beat by a healthy amount on both the top and bottom lines.? Whether out of hedge fund mischief, MR Greenberg selling out of spite, or that the buy-side had gotten ahead of the sell side because of prior good earnings this quarter, AIG stock traded down in the after hours.? Hallmark Financial Services, primarily a personal lines insurer, met estimates.? Nothing amazing one way or another.

Insurance Earnings So Far 1Q07 — X

Posted on 9 May 2007 by David Merkel

With a few exceptions (young company, etc.) late reporters tend not to do as well versus expectations as earlier reporters do.? Well, in issue 10 of this this series, it feels like the cat dragged in many of these reports.

Life

Alas, but a company that has given me a hard time many times over.? Scottish Re missed earnings badly.? Oh, they’re solvent now, just ask Cerberus or Mass Mutual, or the banks that are extending finance to them.? Will they be able to write significant new business at present?? Not likely for a while.? Will they make money in 2007?? That is anyone’s guess.

Primary Casualty

ProAssurance beat (the only one today) and AmComp missed.? In general, medmal did well this quarter, so good for PRA, which had flat premiums.? AmComp, if anything wrote less business, which might be conservative, but hurt current earnings.? That hasn’t been a recipe for stock price outperformance.

Financial

American Capital Access and Primus Guaranty both missed.? In general, I feel there is little franchise value to these companies that deal in credit default swaps and suchlike.? Much of the reason for the miss is rising credit spreads through the quarter.? That very well may revert over the next quarter.

Personal Lines

Bristol West misses badly, with the loss ratio up.? Since Zurich sees enough value to buy this company out, I only wish them well.? They will need all the good wishes that they can get.? National Atlantic, a company that my employer has a large investment in, met estimates today, but had better revenues than expected.? More of the business mix moves to homeowners and small business commercial, and away from auto.? How many insurance companies do you know that have growing revenues, trade at a single digit forward earnings multiple, and trade below book (and book is conservative)?? Don’t think too hard here, there aren’t many.

Earnings season is drawing to a close.? There are a few more companies to go, and I will bring them to you over the next few days.

Full Disclosure: very long NAHC

Insurance Earnings So Far 1Q07 — IX

Posted on 9 May 2007 by David Merkel

Earnings season finally slows down.? Here’s some commentary on what companies reported on Tuesday.

Life

Protective Life beats and raises.? Last quarter, many parties got hung up on an accounting adjustment, and drove the stock down.? This quarter there is no adjustment, but instead an improvement in margins, so PL guides up.? Conseco misses; the clean-up of their administration systems persists, though these adjustments should be over with the second quarter report.? The old LTC block is still an albatross.? The sale of the annuity lines to Swiss Re with an expanded buyback may provide some price support tomorrow, but perhaps at a lower level.

Universal American misses, but the stock goes up because of the purchase of a private Pharmacy Benefits Manager, MemberHealth.? It certainly seems like they got a favorable p;rice, but they had to issue a lot of stock to make the deal work.

The Bermudans

Allied World beats handily.? The price action tomorrow may be muted by their conservatism in not writing so much premium in the first quarter.

Brokers

Marsh Mac misses on higher revenues overall. I don’t think they have worked out how to replace lost contingent fee income from their brokerage businesses.

Primary Casualty

HCC beats on higher revenues; all segments show some improvement?? The big news is that they see opportunities to grow profitably at present.? Wonderful news if true.

Now to bed; I am? beat.

Full disclosure: long AWH CNO

Insurance Earnings So Far 1Q07 ? VIII

Posted on 7 May 20077 May 2007 by David Merkel

Before I start, some additional commentary on M&A items. It was interesting to see Liberty Mutual buy Ohio Casualty for several reasons:

At the premium that they paid, there were better things to buy. I don’t find a 6% return on capital to be that attractive, and I don’t see a lot of synergies.
It implies that there is not that much for sale among stock P&C companies.
Primary Casualty companies buying Bermuda reinsurers makes a lot of sense (like AGII/PXT). This isn’t as cogent.
It lowers my previously high opinion of Liberty Mutual.

On another note, I found the announcement from KMG America to be lightweight. After the stock fell so hard, I had a look at it, and concluded that the purchase GAAP accounting adjustments stripped profits out of the old stable blocks of business to hide losses in the LTC block. Now, that’s just a guess on my part. I could be dead wrong. That said, I would not be surprised to see that KBW finds only limited opportunities for capital enhancement.

On to earnings:

Life

KMG America missed, taking a number of charges, and hiring an investment banker. The stock went up. FBL Financial beat by a small amount.

Title

Investors Title beat earnings. In a very mixed quarter for title earnings, the smallest of the five did well.

Personal

Mercury General and Safety Insurance both beat earnings. Mercury expanded their writings and Safety contracted them slightly. Safety had the bigger beat, though.

Primary Casualty

NYMAGIC, Amerisafe, and Ameritrust all beat earnings, with growing revenues. Ameritrust Financial deserves special mention because it came public recently through unusual means; they listed the stock on NASDAQ, and allowed the private equity holders to go “free to trade.” I can think of another example of that, Quanta Holdings, but AFSI lookws more stable than Quanta.

Conglomerates

Berkshire Hathaway meets earnings, but what can I say? Earnings aren’t very relevant to the way the marginal investor views Berky. The insurance pricing cycle does mean something here, and Buffett was honest enough to inform investors that insurance earnings will likely not be as good next year.

The Bermudans

Max Capital Group beat earnings but on lower written premiums. It will be interesting to see how it fares tomorrow.

Full Disclosure: Long SAFT

Insurance Earnings So Far 1Q07 ? VII

Posted on 3 May 2007 by David Merkel

Things are slowing down, but not much.? Here’s my summary of Thursday’s earnings:

Financial

RAM Holdings beats handily, and Assured Guaranty beats.? I used to own RAM Holdings, but I kicked it out because of the negative macro view of the firm that I work for.? Absent the negative macro view, I would have loaded the boat in the twelves and hung on.? I like the management team and the strategy.

Life

Nationawide and Phoenix both beat.? Big beat for Phoenix, and the stock price was up 5%.? Both are heavily levered to equity prices, so the beat should not be so surprising.
Manulife met estimates and the price fell a little.? Manulife is a company where I don’t get the valuation; it seems too high.? As pointed out yesterday, American Equity missed and fell hard today.? UnumProvident rose as it demonstrated its turnaround through beating earnings on Wednesday after the close.

Brokers

Aon reports and beats on higher revenues.? It seems like the big brokers are beating, while the smaller brokers are missing.? They are different business models.

Primary Commercial

PMA Capital and Tower Group beat, while Specialty Underwriters Alliance missed.? Revenues grew at all of them, and generally continued a 1Q07 theme: so long as earnings are decent enough, the market prefers companies that are growing the top line.

Title

First American misses. They foresee a slowdown in their business and will be looking to reduce expenses.? A writedown here, a writedown there.? FAF is well-managed in my opinion, so if the stock falls tomorrow, it won’t stay there for long.

Personal Lines

Kingsway and Twenty First Century Holdings both miss.? Kingsway is has a high loss ratio from a troublesome acquisition, and the stock goes down 11%.? TCHC cuts earnings giuidance in half because of the onerous nature of Florida personal lines regulation.? The stock falls 45% in the aftermarket on Thursday.? My guess is it finishes up from there, but running a personal lines company with a large Florida exposure is risky; that should not be news to anyone.

The Bermudans

Odyssey Re beats, continuing the pattern of strong earnings on low cats.? They wrote less business, so perhaps gains tomorrow will be muted.? The earnings of Endurance Specialty were pretty good, but their conservatism in new writings was not appreciated by investors, and the stock was down more than 2%.

In summary: Great quarter for primary commercial and the Bermudans.? Good quarter for Life insurance and Financial insurance.? So-so quarter for brokers, personal lines and title.? Poor quarter for mortgage insurers.? Conservatism is not appreciated at present.? Absent catastrophes, I would be inclined to see these trends continue into the next quarter.

Full disclosure: long ENH (take heart, Ken LeStrange!)